Method and system for calculating an intraday indicative value of leveraged bullish and bearish exchange traded funds

ABSTRACT

A computer implemented method, system, and software for calculating and using an intraday indicative value of a leveraged Bullish or Bearish exchange traded fund (“ETF”) for arbitrage purposes, includes calculating an intraday current value of all the equity securities in the ETF (applicable only to Bullish ETFs), calculating mark to market gains or losses of at least one derivative product, and retrieving an accumulated loss or gain of the at least one derivative product and other cash equivalent amounts. The intraday indicative value of the ETF is determined by combining the calculated intraday current value of all the equity securities (applicable only to Bullish ETFs), the accumulated loss or gain, the mark to market gains of the at least one derivative product and other cash equivalent amounts. The determined intraday value of the ETF is used, by a party, for arbitrage purposes.

CROSS-REFERENCE TO RELATED APPLICATIONS

This application claims the benefit of priority under 35 U.S.C. §119(e)of provisional application Ser. No. 60/668,601 filed on Apr. 6, 2005,and provisional application Ser. No. 60/719,985 filed on Sep. 26, 2005,the disclosures of which are incorporated herein in their entireties.

BACKGROUND OF THE INVENTION

The present invention relates generally to the field of exchange tradedfunds. In particular, it relates to a method and system for calculatingan intraday indicative value for leveraged bullish and/or bearishexchange traded funds (“ETF”).

Shares of ETFs are traded intraday throughout the exchange tradinghours. Investors can buy or sell these shares anytime during the tradinghours and achieve the performance of a stock or bond portfolio as asingle security. Currently, all of the ETFs listed on the U.S. Exchangesare “Index Funds or Trusts” that track specific market indexes. However,leveraged bullish and bearish ETFs (individually “Bullish ETFs” or“Bearish ETFs” and together “Bullish and Bearish ETFs”) have only beenproposed recently.

SUMMARY OF THE INVENTION

In certain embodiments the present invention relates to a computerimplemented method of calculating and using an intraday value of aBullish ETF for arbitrage purposes, comprising the steps of:calculating, or having calculated, an intraday current value of all theequity securities in the ETF; calculating, or having calculated, mark tomarket gains or losses of at least one derivative product; retrieving,or having retrieved, an accumulated loss or gain of the at least onederivative product; retrieving other cash equivalent amounts;determining, or having determined, the intraday value of the ETF bycombining the calculated intraday current value of all the equitysecurities, the accumulated loss or gain and the mark to market gains orlosses of the at least one derivative product; and other cash equivalentamounts; and using the determined intraday value of the ETF, by a party,for arbitrage purposes.

In certain embodiments, the derivative product comprises one or more ofa swap contract, a forward contract, a futures contract, an optionscontract or the like.

In certain embodiments, the step of determining the intraday value isperformed in near real time.

In certain embodiments, the method further comprises: comparing, by theparty, of the determined intraday value of the ETF to a traded value ofthe ETF; and performing, by the party, an arbitrage transaction if thedifference between the determined intraday value of the ETF differs fromthe traded value of the ETF by a threshold value.

In certain embodiments, the method further comprises calculating abalancing amount for purposes of fund share creation or redemption thatis composed largely of the gain or loss of at least one derivativeproduct.

In certain other embodiments, the present invention provides a computerimplemented method of using an intraday value of a Bearish ETF forarbitrage purposes, comprising the steps of: calculating, or havingcalculated, mark to market gains or losses of at least one derivativeproduct; retrieving, or having retrieved, an accumulated loss or gain ofthe at least one derivative product; retrieving, or having retrieved,other cash equivalent amounts; determining, or having determined, theintraday value of the ETF by combining the accumulated loss or gain, themark to market gains or losses of the at least one derivative product;and other cash equivalent amounts; and using the determined intradayvalue of the ETF, by a party, for arbitrage purposes.

In certain embodiments, the above mentioned method further comprisesreceiving an IIV File (as defined herein) comprising values for: valueof all the equity securities in the ETF (only applicable for BullishETFs); notional value of at least one derivative product; an accumulatedloss or gain of the at least one derivative product; and other cashequivalent amounts. The received IIV File is used to determine anintraday value of the ETF by combining the calculated intraday currentvalue of all the equity securities (only applicable for Bullish ETFs),the accumulated loss or gain, the mark to market gains or losses of theat least one derivative product; and other cash equivalent amounts, andthe determined intraday value of the ETF is used for arbitrage purposes.

In certain other embodiments, the present invention provides a computerimplemented method of providing an IIV File for a Bullish or BearishETF, comprising: (1) periodically creating an IIV File comprising valuesfor: value of all the equity securities in the ETF (only applicable toBullish ETFs); notional value of at least one derivative product; anaccumulated loss or gain of at least one derivative product; and othercash equivalent amounts; and (2) periodically sending the created IIVFile to other parties.

Certain embodiments provide a computer readable medium having programcode recorded thereon for calculating and using an intraday indicativevalue of a bullish exchange traded fund (“ETF”) for arbitrage purposeswhen executed on a computing system, the program code including: codefor calculating an intraday current value of all the equity securitiesin the ETF; code for calculating mark to market gains or losses of atleast one derivative product; code for retrieving an accumulated loss orgain of at least one derivative product; code for determining theintraday indicative value of the ETF by combining the calculatedintraday current value of all the equity securities, the accumulatedloss or gain and the mark to market gains of the at least one derivativeproduct; and code for using the determined intraday value of the ETF, bya party, for arbitrage purposes.

Certain other embodiments provide a computer readable medium havingprogram code recorded thereon for calculating and using an intradayindicative value of a bearish exchange traded fund (“ETF”) for arbitragepurposes when executed on a computing system, the program code includingcode for calculating mark to market gains or losses of at least onederivative product; code for retrieving an accumulated loss or gain ofat least one derivative product; code for determining the intradayindicative value of the ETF by combining the accumulated loss or gainand the mark to market gains of the at least one derivative product; andcode for using the determined intraday value of the ETF, by a party, forarbitrage purposes.

Certain embodiments provide a system for calculating and using anintraday indicative value of a bullish exchange traded fund (“ETF”) forarbitrage purposes, including: a communication unit configured toreceive an IIV file comprising a value of all equity securities in theETF, the notional value of at least one derivative product. anaccumulated gain or loss of the at least one derivative product, andother cash equivalent amounts; and a computing unit configured tocalculate an intraday current value of all the equity securities in theETF, calculate mark to market gains or losses of at least one derivativeproduct, and determine the intraday indicative value of the ETF bycombining the intraday current value of all the equity securities, theaccumulated loss or gain and the mark to market gains of the at leastone derivative product; and the computing unit configured to compare theintraday indicative value of the ETF to a market value of the ETF on aper share basis to make a determination for arbitrage purposes.

Certain other embodiments provide a system for calculating and using anintraday indicative value (“IIV’) of a bearish exchange traded fund(“ETF”) for arbitrage purposes, including: a communication unitconfigured to receive an IIV file comprising a notional value of atleast one derivative product, an accumulated loss or gain of the leastone derivative product, and other cash equivalent amounts; a computingunit configured to calculate mark to marked gains or losses of the atleast one derivative product, retrieve an accumulated loss or gain ofthe at least one derivative product, and determine the IIV of the ETF bycombining the accumulated loss or gain and the mark to marked gains ofthe at least one derivative product and the other cash equivalentamount, and said computing unit configured to compare the IIV of the ETFto a market value of the ETF on a per share basis to make adetermination for arbitrage purposes.

BRIEF DESCRIPTION OF THE DRAWINGS

The accompanying drawings, which are incorporated in and constitute apart of the specification, illustrate embodiments of the invention andtogether with the description, serve to explain the principles of theinvention.

FIGS. 1 and 2 show formats of an exemplary IIV File.

FIG. 3A is a flow diagram illustrating the general steps of an IIVcalculation.

FIG. 3B is a diagram that illustrates the steps of calculating an IIVwith exemplary data.

FIGS. 4 and 5 are diagrams that illustrate exemplary process flows ofcreating and redeeming Bullish and Bearish ETFs.

FIG. 6 provides exemplary calculations of the balancing amount for aBullish ETF.

FIG. 7 illustrates the components of a generic computing systemconnected to a general purpose electronic network.

DETAILED DESCRIPTION OF THE PREFERRED EMBODIMENTS Introduction

In certain embodiments, the present invention relates to Bullish andBearish ETFs and systems and method for calculating and transmittingvalues of the bullish and bearish ETFs that may be used for arbitragepurposes so that efficient markets for these ETFs are facilitated.

Examples of such Bullish and Bearish ETFs may be based on variouswell-known indexes as listed below. It should be noted that the indexesand the percentages listed below are exemplary only and the principlesof the present invention would apply to other indexes and percentages aswould be recognized by one skilled in the art. The investment objectivefor a Bullish or Bearish ETF is to track a percentage of the performanceof the index, with the percentage being any multiple greater than, equalto or less than 100% of the performance of the underlying index. Thefollowing are some examples:

Name Investment Objective Bullish ETFs Ultra S&P 500 ProShares +200% ofthe performance of S&P500 Index on a daily basis Ultra QQQ ProShares+200% of the performance of Nasdaq100 Index on a daily basis Ultra Dow30 ProShares +200% of the performance of Dow Jones Industrial Average ona daily basis Ultra Mid-Cap 400 +200% of the performance of ProSharesS&PMidCap400 Index on a daily basis Bearish ETFs Short S&P 500 ProShares−100% of the performance of S&P500 Index on a daily basis Short QQQProShares −100% of the performance of Nasdaq100 Index on a daily basisShort Dow 30 ProShares −100% of the performance of Dow Jones IndustrialAverage on a daily basis Short Mid-Cap 400 −100% of the performance ofProShares S&PMidCap400 Index on a daily basis UltraShort S&P 500 −200%of the performance of S&P500 ProShares Index on a daily basis UltraShortQQQ ProShares −200% of the performance of Nasdaq100 Index on a dailybasis UltraShort Dow 30 −200% of the performance of Dow Jones ProSharesIndustrial Average on a daily basis UltraShort Mid-Cap 400 −200% of theperformance of ProShares S&PMidCap400 Index on a daily basis

Operations and management of ETFs require various technical processes toensure the effectiveness of intended product design. More specifically,as the shares of the ETFs are traded on an Exchange, their tradingprices are supposed to stay close to the “fair value” of the sharesthroughout the trading hours. Various processes need to be in place toachieve that result.

In order to achieve these features successfully, ETFs offer themechanisms that encourage effective arbitrage activities by theinstitutional market participants, which are typically majorbrokers-dealers and investment banks. Two of the important mechanismsthat allow effective arbitrage activities are: near real-time IntradayIndicative Value (“IIV”) calculation and Continuous Creation/Redemption.Each of these two mechanisms is discussed in detail in the two partsfurther herein.

As discussed in certain embodiments with respect to the Bullish ETFs andBearish ETFs, these mechanisms work differently when compared to otherexisting ETFs. Certain embodiments of the present invention provideunique computer implemented techniques and processes to ensure at leastequivalent accuracy and effectiveness relative to processes that arecurrently available with respect to other ETFs.

Part I. Indicative Intraday Value (“IIV”) Calculation for Bullish ETFs

A. Definition and Role of IIV

Exchange Traded Funds (“ETFs”), similar to the traditional mutual funds,are required to calculate the “official closing” net asset value (“NAV”)per share, based on 4 pm (or at some fixed time) closing prices and/orfair values of the securities held in the fund once per day on everybusiness day.

Unlike the traditional mutual funds, shares of ETFs trade on theexchanges throughout the trading hours, and the “estimated real-timevalue” of the ETF, in terms of value per single share is calculated anddisseminated by a third party (typically the Primary Listing Exchangefor the ETF). This estimated real-time value is called “IIV”, and istypically updated frequently, for example, every 15 seconds duringmarket hours (market makers are able to calculate IIV on a real-timebasis). It should be noted that, while the IIV is also referred to as“Underlying Trading Value (UTV)” among some market participants, in thisapplication only the term IIV is used.

Generally, IIV is calculated by valuing the sample subset of the assetsheld in the ETF at current prices during the market hours. Thiscalculation methodology is similar to the basic concept employed tocalculate an official closing NAV (at the end of the business day)required for both traditional mutual funds and conventional ETFs.Therefore, IIV based on the 4 pm closing prices should be almost equalto the official closing NAV of the ETF.

By comparing these IIV figures to the trading price of the respectiveETFs, one would know whether the current trading price (or bid-askprice) of a particular ETF is at premium or discount relative to itsindicative real-time value. For example, if the IIV of an ETF shows $100compared to the quoted price of $102 at a particular moment, it wouldindicate that the ETF shares are traded at premium (i.e., at a higherprice than the fair value of $100.)

IIVs also play an important role for the institutional marketparticipants who are ready to engage in the arbitrage activities whenthe opportunities arise. These institutional participants include, forexample, the exchange specialists, market makers, and otherarbitrageurs. One of the key institutional participants are “AuthorizedParticipants (APs)” who carry out the important functions, includingmarket making and arbitrage activities, in the ETF market place. APs arethe only entities that can create (buy) or redeem (sell) the ETF sharesdirectly with the fund that issues the ETF. Part II, further herein,provides additional information of the role of APs with respect tocreation and redemption of ETF shares directly with the fund. Being ableto calculate the accurate IIV is critical for these participants sinceit allows them to actively engage in market making and arbitrageactivities, which in turn, keeps the trading price of the ETF sharesclose to the real-time fair value. The success and value of thismechanism becomes apparent when compared to the persistent andsignificant premium/discount facing closed-end funds. Although theshares of the closed-end funds also trade on the exchanges, the “closed”structure does not provide the same effective arbitrage mechanism thatthe “open-end” ETFs offer since the shares of the closed end funds aretypically fixed in absence of a share offer.

B. IIV Calculation Methodology for Conventional Index-Based ETFs

To facilitate the calculation of IIV for a share of a conventional ETF,the ETF advisor, with the collaboration of the Index Receipt Agent,prepares and transmits a specially formatted file, known as the“Portfolio Composition File (PCF)”, to the National Securities ClearingCorporation (“NSCC”) each business day. PCF contains a complete data setwith which a third party can use to calculate the IIV of the ETFthroughout the trading hours since the fund holdings information in thedata set (held by the ETF) does not change during the course of the day.

The PCF is prepared to represent a single “Creation Unit” whichtypically consists of 50,000 shares of the ETF. In certain embodiments,a Creation Unit is the minimum size that APs can create or redeem fundshares directly with the statutory trust creating the units. Directtransactions with the ETF are typically only permitted in a multiple ofthe Creation Units through an AP. Part II, further herein, providesdetails of direct transactions with ETFs for the creation or redemptionof ETF shares (typically in Creation Units). If the price of one shareis $100, the value of one Creation Unit, consisting of 50,000 shares,would be $5,000,000. Other investors who do not have large number ofshares to trade and/or are not acting as APs can buy and sell the ETFshares (in lot sizes different than a creation unit) on the exchangesthrough their brokers.

The PCF may be downloaded by all entities with a link to the NSCC system(e.g. stock exchanges, APs). These entities are able to download the PCFof an ETF from NSCC, upon the receipt and processing of data by the NSCCfrom the particular ETF investment advisor. Based on these PCFs, APs andexchanges are able to calculate an accurate near real-time IIV duringthe trading hours.

Conventional index-based ETFs, similar to traditional index-based mutualfunds, generally hold the same securities that are contained in theUnderlying Index that the fund tracks. Any residual cash, if any, istypically invested in various money-market or other short-term cashinstruments. Therefore, the data set shown in a PCF represents aproportional subset of the ETF's entire asset structure, proportionatelyprepared in terms of one Creation Unit.

IIV for the conventional ETFs are determined by the following steps: (i)calculating the current value of the Deposit List (list of thesecurities as provided in PCF) based on the last sale prices, (ii)adding the amount calculated in (i) above to the estimated cash/moneymarket instruments (as provided in PCF) to arrive at a cumulative value,and then (iii) dividing the cumulative value by the number of shares perCreation Unit Aggregation (which is the number of shares per creationunit) in order to obtain the estimated current value on a per sharebasis.

C. IIV Calculation Methodology for Bullish ETFs

In accordance with certain embodiments of the present invention, thissection discloses the IIV calculation methodology for a Bullish ETF. Forexample, the investment objective of a Bullish ETF may be to achieve200% of the performance of an underlying index on a daily basis. Thatis, the Bullish ETF seeks to achieve a gain or loss that is 200% of therespective gain or loss of the underlying index on a daily basis. Ofcourse, one skilled in the art would recognize that the percentage(200%) and the time period (daily basis) may be varied withoutsignificantly altering the principles of the present invention.

In order to achieve the targeted leverage (i.e., for example 200%), theproposed Bullish ETF utilizes various financial instruments, includingderivatives, in addition to equity securities in managing the portfolioexposure and to capture a movement proportional to the targetedleverage.

In contrast, conventional ETFs generally do not carry the derivativeproducts as part of their holdings. Therefore, the data in the PCF (usedby the conventional ETFs) is simply the list of equity or debtsecurities. The current format of the PCF that is compatible with theNSCC system is not designed to accommodate the various derivativecontracts that the present invention utilizes for the management of theBullish and Bearish ETFs.

As a result, in certain embodiments, the present invention provides fora separate file, named “IIV File,” to complement the PCF as a way toprovide an adequate data set for IIV calculation of a Bullish ETF. TheIIV File is designed to provide detailed information about thederivatives positions in the Bullish ETF and all other information thatis necessary for the accurate near real-time IIV calculation.

FIG. 1 shows an exemplary format of an IIV File 100 that may be used incertain embodiments of the present invention and FIG. 2 providesexamples of headers and symbols (in a table 200) that may be used in theIIV File. It should be noted that FIGS. 1 and 2 are exemplary only andone skilled in the art would recognize various other modifications andalternatives all of which are considered as a part of the presentinvention. As shown in FIG. 1, the exemplary file format 100 is depictedwith headers (which represent exemplary data fields) and various symbolsand values representing data corresponding to each of the headers (whichrepresent data fields). FIG. 2 provides examples of how the headers andsymbols may be constructed in one embodiment of the computerimplementation of the present invention. For example, the table 200 (inFIG. 2) illustrates the type of symbols that may be used in data fields(corresponding to specific headers) and also specifies a description ofthe meanings of the various symbols.

The daily IIV File may be provided via a secure website and is preparedto show all the necessary information of the entire ETF assets, asopposed to a subset of the proposed ETF assets (which is contained in aconventional PCF file), to ensure the accuracy of the IIV calculation.The PCF may still be prepared in terms of one Creation Unit and be madeavailable through NSCC. It should be noted that the concept of an IIVFile represents a formulaic or logical file which is implemented in adata processing system using techniques that are well known to thoseskilled in the art. One skilled in the art would also recognize thatstreaming or other evolving technologies may be used to transmit oraccess an IIV File (using wireline, optical, or wireless communications)and all such technologies are considered to be a part of the presentinvention.

The exchange and APs (or other parties that need to calculate, or havecalculated, a near real-time IIV) require both PCF and IV Files tocalculate the IIV of Bullish ETFs. Alternatively, as would be recognizedby one skilled in the art, the relevant information from the PCF filemay be included in the IIV file so that one logical file contains allthe information required to compute the IIV of the bullish ETF.

As shown in FIG. 3A, in certain embodiments, the IIV is determined bythe following steps. (i) In step 302, calculating the estimated currentvalue of equity securities held by the ETF by calculating the percentagechange in the value of the Deposit List (that is the list of securitiesprovided in the PCF) and applying that percentage value to the totalvalue of the equity securities in the ETF as of the close of trading onthe prior trading day (as provided in IIV File). (ii) In step 304,calculating the mark-to-market gains or losses from the ETF's totalreturn equity index swap exposure based on the percentage change of theUnderlying Index and the previous day's notional values of the swapcontracts, if any, held by such ETF (which previous day's notional valueis provided in the IIV File). It should be noted that the samecalculation is also applied to other similar forms of over-the-counterderivative contracts such as forwards and contracts for difference.(iii) In step 304, also calculating the mark-to-market gains or lossesfrom futures and/or options positions by taking the difference betweenthe current value of the futures and/or options contracts held by theETF, if any, and the previous day's value of such positions (as providedin IIV File). (iv) In step 306, adding the values from (i), (ii), and(iii) above to an estimated cash amount (which cash amount includes theswap costs) (as provided in IIV File) to arrive at a value, and (v) instep 308, dividing that value by the total shares outstanding (asprovided in IIV File) to obtain the current IIV per share.

These four steps are also illustrated as steps 310-340 in FIG. 3B whichshows the application of these steps to an exemplary calculation of anIIV. In step 310, a current value of the equities is calculated from acurrent value of the securities included in the PCF by accounting forthe percentage change (1% in the illustrated example) in value of thedeposit list of securities in the PCF, with the percentage changeapplied to the previous day's value of total securities in the IIV File.In step 320, the current gains or losses from the swaps and futures arecalculated to derive a mark-to-market gain or loss for the swaps and thefutures. In step 330, the current total net assets are calculated byadding the total values of the equities, the gains or losses from thederivatives (swaps, futures, etc.) and net other assets (includingcash). In step 340, the total net assets are divided by the total numberof shares outstanding to arrive at the IIV per share.

D. IIV Calculation Methodology for Bearish ETFs

The investment objective of a Bearish ETF funds is to achieve, forexample, (−100%) of the performance of the underlying index on a dailybasis. That is, if the underlying index decreases by a certainpercentage on a certain day, the objective of the Bearish ETF would beto increase by the same percentage on that day and vice versa.

In order to achieve the targeted leverage, the present inventionutilizes various financial instruments, including futures and swaps, inmanaging the portfolio exposure. In other words, a total of (−100%)portfolio exposure is achieved through various financial instruments,mostly derivative products. As these Bearish ETFs do not invest inequity securities, leftover cash is invested in the money marketinstruments, including repurchase agreements.

As the current format of the PCF (used with conventional ETFs) that iscompatible with the NSCC system is not designed to accommodate thevarious derivative contracts that are used with the present invention,certain embodiments of the present invention provide a separate file,named “IIV File,” that contain the detailed information about thederivatives positions in the fund and all the other information that arenecessary for an accurate IIV calculation. Structure of the IIV File forBearish ETFs is substantially similar to the one prepared for theBullish ETFs as shown in FIGS. 1-2 except that the fields and datarelated to the equities is missing or not used.

The daily IIV File may be provided via a secured website and is preparedto show all the necessary information of the entire ETF assets in orderto ensure the accuracy of IlV calculation. As Bearish ETFs do not intendto invest in equities, there is no need for a PCF to be prepared for theBearish ETFs.

The Exchanges and APs (or other third parties), using the IIV File, cancalculate IIV using the following step: (i) Calculating, or havingcalculated, the mark-to-market gains or losses from the ETF's totalreturn equity index swap exposure based on the percentage change to theUnderlying Index and the previous day's notional values of the swapcontracts, if any, held by such ETF (which previous day's notional valueis provided in IIV File). It should be noted that the same calculationis also applied to other similar forms of over-the-counter derivativecontracts such as forwards and contracts for difference. (ii)Calculating, or having calculated, the mark-to-market gains or lossesfrom futures and/or options positions by taking the difference betweenthe current value of the futures and/or options contracts held by theETF, if any, and the previous day's value of such positions (as providedin IIV File). (iii) Adding the values from (i) and (ii) above to anestimated cash amount (which cash amount includes the swap costs) (asprovided in IIV File) to arrive at a value, and (iv) dividing that valueby the total shares outstanding (as provided in IIV File) to obtain thecurrent IIV per share. See FIG. 3B for steps and an exemplarycalculation of an IIV with the only change being that there would be nostep 310 for the IIV calculation of a Bearish ETF since there are noequity positions held in a Bearish ETF.

Unique Features of the Present Invention

For both Bullish and Bearish ETFs, the present invention provides aunique IIV File. For Bullish ETFs, the provided IIV File supplements thestandard PCF file which is the only data set used in conventional ETFs(or alternatively the IIV file contains all the information in the PCFfile and contains additional information related to the derivativepositions and swap contracts). In the case of Bearish ETFs, IIV Filerepresents, in certain embodiments, the whole data set that enables theIIV calculation since no PCF is needed because the Bearish ETFs do nothold any equity positions. FIGS. 4-6 discussed further herein disclosethe process of using the IIV File in the creation and redemption processof the Bullish and Bearish ETFs.

It should be noted that when calculating the daily NAV for the mutualfunds and ETFs that contain derivatives positions, gains or losses fromderivatives are reflected in NAV on an “accumulated” basis, assuming thederivatives positions are established and remain open over a period oftime. That is, the periodic (for example, daily) gains or losses fromthe derivatives are carried forward and accumulated over the period oftime during which the respective derivative positions are open.Therefore, in calculating IIV for Bullish and Bearish ETFs, theinformation regarding the “accumulated” gains or losses from allderivatives positions, as of end of the previous business day, needs tobe delivered to the APs and an Exchange (or any party that calculatesthe IIV on an intraday basis). Therefore, the IIV File provides themechanism by which these accumulated gains or losses are provided, forexample, in the fields corresponding to the “net other assets” or NOAdisclosed in the IIV File format shown in FIGS. 1 and 3B. It should benoted that the calculation of “mark-to-market” gains or losses forderivatives, described above as part of the IIV calculationmethodologies for Bullish ETFs and Bearish ETFs (for example as shown inFIG. 3B), provides gain/loss figures only for the period between lastnight's closing to current time. Therefore, the accumulated gains orlosses as they exist for the derivatives in the Bullish and Bearish ETFsare not available to the party performing the calculation except bybeing provided by the particular IIV file as provided by certainembodiments of the present invention. Accordingly, the information fromthe IIV File provided by the present invention can be used to accuratelycalculate the IIV for the Bullish and Bearish ETFs since the accumulatedlosses and gains of the derivatives are provided in the IIV File andthis information is not otherwise available to a third party from anyother source.

Part II. Creation and Redemption of Bullish and Bearish ETFs

FIGS. 4 and 5 are diagrams that illustrate exemplary process flows forcreating and redeeming Bullish and Bearish ETF shares with the statutorytrust that issues the particular ETF shares. In practice, Bullish ETFssettle through NSCC as illustrated in FIG. 4 while Bearish ETFs do notuse the NSCC facility as illustrated in FIG. 5. One skilled in the artwould recognize that the particular entities described here in thecreation and redemption process are exemplary only and other suchentities (or combinations thereof) could perform the functions disclosedherein in the creation and redemption process for the ETFs.

A. Creation/Redemption Mechanism for Conventional Index-Based ETFs

Purchases (creations) and sales (redemptions) “directly” with theExchange Traded Fund (ETF) can be done only in a multiple of a “CreationUnit”, which typically consists of 50,000 Shares. In addition, thesedirect creations and redemptions can only be initiated by APs who haveexecuted a Participant Agreement with the ETF. The dollar value of asingle Creation Unit generally exceeds $1 million dollars. For example,an ETF with a $100 NAV per Share would have a Creation Unit value of$5,000,000 ($100×50,000 Shares).

Other investors (for example, retail investors) buy and sell the FundShares in the secondary markets through their brokers. Trades executedin the secondary market (e.g. the primary listing exchange, ECN) do nothave any direct impact on the operation of the ETF.

The continuous ability of an AP to create or redeem ETF shares allowsAPs to engage in the market making and arbitrage activities and therebyeffectively and efficiently keep the price of the ETF Shares traded onthe exchange close to the real-time value (IIV) of the ETF during thetrading hours.

Generally, creations and redemptions are transacted on an “in-kind”basis. When APs create ETF shares (in creation units), APs receive theETF shares from the statutory trust and deliver the securities asspecified in PCF (which represent the securities held by the ETF). WhenAPs redeem the ETF shares (in creation units), the opposite occurs, thatis, the APs exchange the ETF shares for the securities held by the ETF.If the values of the two (ETF shares vs. securities) do not match, cashis paid or received to equalize the difference. The cash to equalize thevalues of the two sides is called “Balancing Amount.”

Typically, conventional index funds maintain “fully invested” positionsin the securities that make up the underlying index. As a result, almostthe entire portion of the assets in the conventional index-based ETFscomprises the equity or fixed-income securities. Therefore, any cashamount as Balancing Amount that has to be paid or received is generallysmall in the creations or redemptions of the conventional ETFs. In otherwords, the difference between the value of one Creation Unit and thevalue of the securities listed in PCF corresponding to one creation isgenerally quite small.

B. Creation/Redemption Mechanism for Bullish ETFs

The Bullish ETFs seek to provide daily investment results, before feesand expenses, that, for example, double (200%) the daily performance ofthe applicable index. That is, the percentage change of the estimatedreal-time value (or IIV) of these ETFs is expected to be approximatelytwice the percentage change of the underlying index at any given momentthroughout the trading hours. The “percentage change” in this context iscalculated by comparing the current market value to the previous day'sclosing value (4 pm official closing NAV for the Fund and 4 pm closingprice for the index). For example, assuming previous day's NAV of theETF is $100 and the underlying index that the Bullish ETF tracksincreased 1% from previous day's close at a particular moment during thetrading hours, the IIV of the ETF at that moment is expected to be at$102, indicating that the ETF's value is up 2% (($102−$100)/$100), whichis twice the percentage change of the index.

Bullish ETFs utilize various derivative products to obtain the necessaryleverage and target exposure as would be recognized by those skilled inthe art. The value of each derivative contract is “marked-to-market”each day, following the change in the value of the underlying securitiesor index. As a result, unlike the conventional index ETFs, value of thesecurities in the PCF (i.e., the securities held by the ETF on aCreation Unit basis) may be significantly different from the value ofone Creation Unit, since the gains or losses from the derivatives arereflected in calculating the value of Creation Unit. It should be notedthat the PCF does not include any derivatives information. In otherwords, the difference between the value of the Securities from PCF andthe value of the shares in the Creation Unit may be much greater than inthe case of conventional ETFs due to the extensive use of derivatives inthe Bullish and Bearish ETFs. For example, the difference may be greaterthan 10% of the value of the Creation Unit and could even be 50% orhigher.

In order to resolve this discrepancy, certain embodiments of the presentinvention expand the concept of Balancing Amount to include the portionthat makes up the leverage. In the conventional ETFs, Balancing Amountreflects daily accruals and is generally small. In contrast, in theBullish ETFs, the present invention uses the Balancing Amount as a wayto reconcile the difference caused by the extensive derivativespositions. In other words, in order to equalize the value of the equitysecurities and value of the Units being created/redeemed, the BalancingAmount in IIV files for the Bullish ETFs includes the accumulatedgains/losses from the derivatives positions. Therefore, Balancing Amountin the IIV file for Bullish ETFs is generally much greater than thebalancing amount value in the IIV file for conventional ETFs.

FIG. 4 discloses an exemplary process flow in the creation andredemption of an ETF creation unit (as defined herein, a creation unitis the minimum aggregation of lot size of ETF shares that are created orredeemed by a fund creation and redemption entity 500. In certainembodiments, each of the blocks shown in FIG. 4 comprise a computingsystem or node while the arrows connected there between disclose networkdata flows between the computing nodes. The flow of information in FIG.4 is discussed first with respect to steps (4) and (5) and is thenfollowed by a discussion of steps (1), (2), and (3).

As shown in steps (4) and (5) of FIG. 4, the creation or redemptionorder is initiated by an authorized participant 500 and the order passesthrough a distributor 510 to an index receipt agent 520 acting on behalfof the ETF issuing Trust. In certain embodiments, each of the blocksrepresent a server or other computing system and the lines representnetwork or other data connections between the servers or computingsystems. It should be recognized that each of the blocks need not be ondifferent computing systems since two or more blocks could reside on onecomputing system. The creation and redemption order is then forwarded,in a continuation of step (4), to a clearing house 530 to initiate thesettlement process. As shown in step (6), the creation and redemptiontransaction is completed by exchanging the ETF shares with thesecurities and a Balancing Amount (corresponding to the difference invalue between the ETF shares and the securities). When creating units,the authorized participant 500 receives ETF shares in exchange for thesecurities. The flow is reversed from the flow discussed earlier forredemptions. In addition, the Balancing Amount is used to equalize thedifference between the value of the ETF shares and securities asexplained further herein with respect to the examples shown in FIG. 6.

FIG. 4 also shows the flow of the PCF file and the IIV File. The PCFfile is transmitted, as shown in step (2), by the Index Receipt Agent tothe clearing house 530 on each business day after receiving theinformation on the securities in step (1) from the Fund Manager. Oncethe PCF has been processed by the clearing house 530, it is available toall NSCC members such as the Authorized Participants 500. The IIV Fileon the other hand is created (also shown as step (3)) by the FundManager also on each business day, in collaboration with FundAccountant, and is made available to the requesting parties, such as theAuthorized Participants 500, so that they can, for example, performarbitrage transactions based on the difference between the IIV of an ETFshare and the market price of the ETF share as traded on an exchange.

FIG. 6 provides exemplary calculations of the balancing amount for aBullish ETF that returns 200% of the return of the underlying index on adaily basis. The fund information from the previous closing is shown intable 725. As shown in table 725, the number of shares on one CreationUnit is 50,000 while the closing NAV per share was 100. Based on thesevalues the value of one Creation Unit is $5,000,000. Furthermore, thevalue of the deposit securities in the PCF is also $5,000,000 and,therefore, the estimated cash amount is zero. Block 705 shows thecalculation of the balancing amount for creation of a creation unit ofthe ETF shares for the situation in which the underlying index hasincreased by 10%. Since the index is up 10%, the NAV per share is up bytwice that amount (20%) from the previous close so that the value of 1Creation Unit is $6,000,000. However, the value of deposit securities isup by 10% (since it tracks the index) to $5,500,000. Accordingly, thebalancing amount has a value of $500,000 since that value-balances thedifference between the value of the ETF shares and the securities heldby the fund (on a Creation Unit) basis. Accordingly, in the creationprocess, the party (for example, an AP) that creates Creation Unit ofETF shares, receives the ETF shares corresponding to one Creation Unitand delivers equities (worth $5,500,000) and cash (worth $500,000).

Block 710 discloses the calculation for the redemption process when theindex is up by 10%. In this case, the AP would deliver the ETF shares(corresponding to one Creation Unit) and would in return receives thesecurities (worth $5,500,000) and a cash balancing amount (worth$500,000).

Block 715 shows the calculation of the balancing amount for the creationof a creation unit of the ETF shares when the underlying index hasdecreased by 10%. In this case, the NAV per share has declined by 20%(200% of the decline of the underlying index) to a value of 80.Therefore, the value of the one Creation Unit is $4,000,000 while thesecurities held by the ETF are worth $4,500,000 (as they declined by 10%corresponding to the decline in the index). Accordingly, when creating 1Creation Unit of ETF shares, the Authorized Party delivers thesecurities (worth $4,500,000) and receives the ETF shares correspondingto 1 Creation Unit (worth $4,000,000) and a cash or cash equivalentbalancing amount of $500,000.

Block 720 shows the calculation of the balancing amount for theredemption of a creation unit of the ETF shares when the underlyingindex has decreased by 10%. In this case, the Authorized Party deliversthe ETF shares corresponding to one Creation Unit (worth $4,000,000) anda cash or cash equivalent balancing amount of $500,000 while receivingthe securities worth $4,500,000 (corresponding to the securities held bythe ETF for one Creation Unit).

Gains or losses from the derivatives positions are settled in cashand/or securities as part of Balancing Amount in creations/redemptions.Unlike the equity securities in the fund, the derivative contracts suchas futures and swaps can not easily be transferred “in-kind.” If such amechanism is found to settle the derivatives “in-kind”, it may bepossible to handle the Balancing Amount by in-kinding the derivatives.

C. Creation/Redemption Mechanism for Bearish ETFs

The Bearish ETF Funds seek to provide daily investment results, beforefees and expenses, that match a certain percentage (e.g. 100% or 200%)of the inverse (opposite) of the daily performance of the applicableunderlying index.

The percentage change of the estimated real-time value (or IIV) of theseFunds is expected to be the inverse of the percentage change of theunderlying index at any moment throughout the trading hours. The“percentage change” in this context is calculated by comparing thecurrent market value to the previous day's closing value (4 pm NAV forthe Fund and 4 pm closing price for the index). For example, assumingprevious day's NAV per ETF Share being $100, if the underlying indexthat the Bearish ETF, with the investment objective of −100% daily,tracks is down 1% from previous day's close at a particular momentduring the trading hours, IIV of the Bearish ETF at that moment isexpected to be at $101, indicating that the ETF's value is up 1%, whichis 100% (or −1) times the percentage change of the index.

Bearish ETFs utilize various derivative products to obtain the targetexposures, and the value of each derivative contract is“marked-to-market” following the change in the value of the underlyingsecurities or index. Consequently, the value of Bearish ETFs aredetermined mainly by the change in the value of those derivativecontracts.

Bearish ETFs do not intend to carry any stocks and therefore, nosecurities are transferred “in-kind” between APs and the statutory trustfor the creations or redemptions unless an efficient and feasible way toin-kind derivative positions is developed in the future. To resolve thisissue, in certain embodiments, the present invention performs thecreations/redemptions for Bearish ETFs as “All-Cash” transactions. Afterdetermining the NAV of the share, total cash amount for creations orredemptions can simply be calculated by multiplying that NAV to thenumber of shares being created or redeemed.

FIG. 5 is an operation flowchart that illustrates the process ofredemption and creation of the Bearish ETF shares. In certainembodiments, each of the blocks represent a server or other computingsystem and the lines represent network or other data connections betweenthe servers or computing systems. It should be recognized that each ofthe blocks need not be on different computing systems since two or moreblocks could reside on one computing system. The processing steps shownin FIG. 5 are very similar to the corresponding steps in FIG. 4 with theexception that the creation and redemption process exchanges the ETFshares with a cash amount (a balancing amount) with no securities asshown in step (4). As shown in the Figure, there is also no PCF filecreated while the IIV File is created on each business day and madeavailable to the Authorized Participants 500 so that they can performarbitrage transactions based on the difference between the IIV of theETF and its market price on the exchange. It should be noted thatcreation and redemption transactions will occur outside the NSCC.

D. Unique Features Related to Creation and Redemption of Bullish andBearish ETFs

In certain embodiments, the present invention provides a uniquemechanism for the creation/redemption process for the Bullish andBearish ETFs by efficiently dealing with the values of derivatives usedto achieve the investment objectives of the Bullish and Bearish ETFs.For the Bullish ETFs, the present invention expands the Balancing Amountconcept to include the “leverage make-up portion” that represents themarket value of derivatives. In the case of Bearish ETFs, in certainembodiments, the present invention uses “All-Cash Payment” procedures toaccount for the value of the derivatives. Because the Bullish andBearish ETFs are the only domestic ETFs which provide leverage or shortexposures through the use of derivatives, the creation and redemptionprocess for units of the Bullish and Bearish ETFs employ a uniquetechnique not used with conventional ETFs. That is, the Balancing Amountor All-Cash Payment in the Bullish and Bearish ETFs include theaccumulated gains/losses from the derivative positions. This featureprovides the advantage that it facilitates the orderly creations andredemptions in the ETF marketplace.

FIG. 7 illustrates the components of a generic computing systemconnected to a general purpose electronic network 10, such as a computernetwork. The computer network can be a virtual private network or apublic network, such as the Internet. As shown in FIG. 7, the computersystem 12 includes a central processing unit (CPU) 14 connected to asystem memory 18. The system memory 18 typically contains an operatingsystem 16, a BIOS driver 22, and application programs 20. In addition,the computer system 12 contains input devices 24 such as a mouse or akeyboard 32, and output devices such as a printer 30 and a displaymonitor 28, and a permanent data store, such as a database 21. Thecomputer system generally includes a communications interface 26, suchas an Ethernet card, to communicate to the electronic network 10. Othercomputer systems 13 and 13A also connect to the electronic network 10which can be implemented as a Wide Area Network (WAN) or as aninternetwork, such as the Internet. In certain embodiments, such acomputer system 12 can be used to implement the third party processingsystem discussed herein including programmed code that implements thelogic discussed herein with respect to FIGS. 1-6. One skilled in the artwould recognize that such a computing system maybe logically configuredand programmed to perform the steps to calculate the IIV as detailed inFIG. 4, implement the IIV file format as disclosed in FIGS. 1-6, performthe functions at each of the nodes (authorized participant 500,distributor 510, or fund creation/redemption entity 540) shown in FIGS.4 and 5, and perform the exemplary balancing amount calculations shownin FIG. 6 at the fund creation/redemption entity 540.

One skilled in the art would recognize that the foregoing describes atypical computer system 12 connected to an electronic network 10. Itshould be appreciated that many other similar configurations are withinthe abilities of one skilled in the art and it is contemplated that allof these configurations could be used with the methods and systems ofthe present invention. Furthermore, it should be appreciated that it iswithin the abilities of one skilled in the art to program and configurea networked computer system to implement the method steps of certainembodiments of the present invention, discussed herein.

As noted above, embodiments within the scope of the present inventioninclude program products comprising computer-readable media for carryingor having computer-executable instructions or data structures storedthereon. Such computer-readable media can be any available media whichcan be accessed by a general purpose or special purpose computer. By wayof example, such computer-readable media can comprise RAM, ROM, EPROM,EEPROM, CD-ROM or other optical disk storage, magnetic disk storage orother magnetic storage devices, or any other medium which can be used tocarry or store desired program code in the form of computer-executableinstructions or data structures and which can be accessed by a generalpurpose or special purpose computer. When information is transferred orprovided over a network or another communications connection (eitherhardwired, wireless, or a combination of hardwired or wireless) to acomputer, the computer properly views the connection as acomputer-readable medium. Thus, any such a connection is properly termeda computer-readable medium. Combinations of the above are also includedwithin the scope of computer-readable media. Computer-executableinstructions comprise, for example, instructions and data which cause ageneral purpose computer, special purpose computer, or special purposeprocessing device to perform a certain function or group of functions.

The invention is described in the general context of method steps whichmay be implemented in one embodiment by a program product includingcomputer-executable instructions, such as program code, executed bycomputers in networked environments. Generally, program code includeroutines, programs, objects, components, data structures, etc. thatperform particular tasks or implement particular abstract data types.Computer-executable instructions, associated data structures, andprogram modules represent examples of program code for executing stepsof the methods disclosed herein. The particular sequence of suchexecutable instructions or associated data structures represent examplesof corresponding acts for implementing the functions described in suchsteps.

The present invention in some embodiments, may be operated in anetworked environment using logical connections to one or more remotecomputers having processors. Logical connections may include a localarea network (LAN) and a wide area network (WAN) that are presented hereby way of example and not limitation. Such networking environments arecommonplace in office-wide or enterprise-wide computer networks,intranets and the Internet. Those skilled in the art will appreciatethat such network computing environments will typically encompass manytypes of computer system configurations, including personal computers,hand-held devices, multi-processor systems, microprocessor-based orprogrammable consumer electronics, network PCs, minicomputers, mainframecomputers, and the like. The invention may also be practiced indistributed computing environments where tasks are performed by localand remote processing devices that are linked (either by hardwiredlinks, wireless links, or by a combination of hardwired or wirelesslinks) through a communications network. In a distributed computingenvironment, program modules may be located in both local and remotememory storage devices.

Other embodiments of the invention will be apparent to those skilled inthe art from a consideration of the specification and the practice ofthe invention disclosed herein. It is intended that the specification beconsidered as exemplary only, with such other embodiments also beingconsidered as a part of the invention in light of the specification andthe features of the invention disclosed herein. Furthermore, it shouldbe recognized that the present invention includes the methods disclosedherein together with the software and systems used to implement themethods disclosed here.

1. A computer implemented method of calculating and using an intradayindicative value of a Bullish exchange traded fund (“ETF”) for arbitragepurposes, comprising the steps of: calculating or having calculated anintraday current value of all the equity securities in the ETF;calculating, or having calculated, mark to market gains or losses of atleast one derivative product; retrieving, or having retrieved, anaccumulated loss or gain of at least one derivative product;determining, or having determined, the intraday indicative value of theETF by combining the calculated intraday current value of all the equitysecurities, the accumulated loss or gain and the mark to market gains ofthe at least one derivative product; and using the determined intradayvalue of the ETF, by a party, for performing an arbitrage transaction,wherein one or more of the above steps are performed on a computingsystem. 2.-23. (canceled)